Spurious Shield: “Pre Existing Dispute” under section 8(2) (a) as a tool to delay CIRP by the Corporate Debtor
Radhika Baderia & Aditya Pratap Singh
3rd Year, B.A. LL.B. (Hons.), National Law Institute University, Bhopal
In the dynamic realm of corporate insolvency and restructuring, where disputes between the corporate debtor and Operational Creditor are common phenomenon. Therefore, a common tactic employed by corporate debtors after issuing a demand notice by the operational creditor they subsequently raise a contention of a “pre-existing dispute” under Section 8(2) of the IBC, 2016,[1] as a means to delay the payment of legitimate operational debts and stall the initiation of the Corporate Insolvency Resolution Process (CIRP) under Section 9 of the Code.[2] This issue recently came to light in the case of Goqii Technologies Private Limited v. Sokrati Technologies Private Limited,[3] where the Supreme Court, while overturning the Bombay High Court’s decision, failed to adequately address the timing of the dispute raised by Goqii. This failure to consider when the allegations were first brought forward led to the setting aside of the Bombay High Court’s judgment.
In this backdrops, this article aims to analyze when a dispute can be considered as a “pre-existing dispute” under section 8 of the code in order to bar the initiation of the CIRP. The authors examine this recent dispute in the light of the Bombay HC judgement and a critical analysis of the subsequent Supreme Court decision while setting the aside the HC order. However, it is to be noted that the existence of the dispute under section 8 of the code require several factual considerations along with the timing of the allegations raised by the corporate debtor.
Brief Facts of the case
The case pertains to a commercial arbitration dispute arising from alleged deficiencies in services provided under a Master Services Agreement (MSA). The agreement, signed on March 11, 2021, and later amended on April 29, 2022, involved Goqii, a provider of lifestyle consulting services through a mobile app and fitness trackers, and Sokrati, a marketing company offering performance and media management services. The agreement outlined objectives such as improving conversion rates and reducing acquisition costs. The dispute arose when Goqii, after engaging Sokrati’s services, claimed to have discovered discrepancies and deficiencies in the quality of service through an independent audit report. The report indicated poor performance in digital marketing campaigns across platforms, resulting in high costs and low returns on investment. Alleging fraudulent practices, Goqii sought a refund of Rs. 5.53 crores, which it had paid against Sokrati’s invoices.
Sokrati refuted these allegations, stating that Goqii had failed to pay outstanding invoices amounting to Rs. 6.25 crores and had only raised concerns about service quality after receiving demand notices. By raising a dispute, Goqii aimed to preclude the initiation of insolvency proceedings, as the existence of a genuine dispute can bar such proceedings under the IBC because Under Section 9(5) (ii) (d) of the IBC,[4] because if the NCLT finds that there is a pre-existing dispute between the parties before the demand notice was issued, it may reject the operational creditor’s insolvency application. Therefore, Sokrati argued that Goqii’s claims were baseless, frivolous, and intended to evade its payment obligations. They also contended that the independent audit report, relied upon by Goqii, did not substantiate the allegations of fraud or gross deficiencies in service.
Observations by the Bombay HC
Justice Dangre found that Goqii’s allegations lacked sufficient substance or evidence to justify referring the matter to arbitration. The court emphasized that a mere assertion of a dispute does not warrant arbitration, particularly if the claim appears to be concocted to avoid contractual obligations.
The High Court of Bombay while analysing the commercial arbitration petition observed the appellant (Goqii) had failed to establish a legitimate pre-existing dispute over the invoices raised by the respondent (Sokrati Technologies). The Court highlighted that the audit report, relied upon by the appellant, did not conclusively demonstrate fraudulent practices or substantive deficiencies in service. While it suggested further investigations, the report alone was insufficient to substantiate the claim of a dispute. The Court found the invocation of arbitration was dishonest, as no dispute was raised during the course of the service period, and issues were only brought up after the respondent served a demand notice under the IBC.
A peculiar point noted by the court was that debtor did not raise any concerns or objections about the respondent’s services while they were being rendered. Furthermore, all the allegations of deficiencies were made only after the respondent issued a demand notice under the IBC. The Court implied that the allegations and the invocation of arbitration were strategically timed to shield the debtor from paying dues and to derail the insolvency proceedings initiated by the respondent. Therefore, the HC refused to appoint the arbitrator on the basis of the dishonest and frivolous claims of the corporate debtor aimed only to negate the initiation of the corporate insolvency.
Observations of the Supreme Court
However, the apex court noted that the Bombay High Court erred by examining the audit report and assessing the appellant’s claims in detail. This approach contravened the legislative intent to limit judicial scrutiny at this stage to the mere existence of an arbitration agreement. The court emphasized that the existence of an arbitration agreement and the appellant’s claims of deficiencies requires adjudication by an arbitral tribunal. It reiterated that the referral court’s scrutiny under Section 11 of the Arbitration and Conciliation Act, 1996,[5] is limited to a prima facie assessment of the arbitration agreement’s existence and should not extend to detailed evaluations of factual disputes.
Critical Analysis of the Supreme Court Judgement
The Bombay High Court’s decision to dismiss Goqii’s application for arbitration in the case against Sokrati was grounded in established legal principles and a practical approach to balancing the objectives of arbitration and insolvency law. By focusing on the prima facie review and aligning with the Mobilox Innovations[6] and Vidya Drolia[7] precedents, the court upheld the objectives of both arbitration and insolvency frameworks.
The Bombay High Court had only given the prima facie examination of the evidence provided by Goqii, including the audit report, correspondence, and invoices, and found no substantial basis for Goqii’s allegations. Goqii had neither contemporaneously disputed the quality of Sokrati’s services nor provided corroborative evidence of fraud or deficiencies.
Need for prima facie Examinations
There is a need for courts to additionally conduct a prima facie examination of the dispute to determine the authenticity of the disputes from fabricated ones, particularly where arbitration and insolvency proceedings intersect since under Section 9 of the Code, the initiation of the CIRP against a corporate debtor is contingent on the absence of a pre-existing dispute.
Therefore, without careful judicial scrutiny, this provision could be misused, allowing debtors to raise baseless disputes to avoid legitimate financial obligations. Hence, this examination could serve as a safeguard against such misuse. It would enable the court to assess whether the purported dispute is genuine and backed by material evidence or merely a tactic to obstruct the CIRP because without this filter, frivolous or dishonest claims could derail insolvency proceedings.
For instance, in Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd., the Supreme Court emphasized that courts must evaluate whether a dispute exists and whether it is bona fide and substantial. This step ensures that the CIRP is not blocked by claims that lack credibility. Similarly, in Innoventive Industries Ltd. v. ICICI Bank,[8] the Court clarified that mere assertions or vague allegations by a corporate debtor cannot bar insolvency proceedings; disputes must be real and demonstrated with credible evidence.
Therefore, had the Bombay High Court referred the matter to arbitration without questioning the genuineness of the dispute, it would have set a precedent allowing corporate debtors to misuse arbitration clauses as a shield against insolvency proceedings.
Conclusion
In this case the Bombay High Court had correctly applied a prima facie review to determine the genuineness of the dispute, highlighting Goqii’s strategic attempt to avoid payment by raising baseless allegations only after receiving a demand notice under the IBC, 2016. The court found that Goqii’s claims, relying on an independent audit report, lacked substantial evidence of fraud or service deficiencies, which led to the dismissal of the arbitration application. The Supreme Court set aside the Bombay High Court’s decision, focusing on the narrow scope of judicial scrutiny under Section 11 of the Arbitration and Conciliation Act, emphasizing that courts should not assess the merits of the dispute at this stage. However, this approach overlooks the potential for misuse of arbitration clauses by corporate debtors to delay insolvency proceedings. While the Supreme Court’s ruling aligns with procedural norms for arbitration, it could set a dangerous precedent by allowing corporate debtors to exploit arbitration to obstruct legitimate debt recovery.
References:
[1] Insolvency and Bankruptcy code, 2016 S 8(2).
[2] Insolvency and Bankruptcy code, 2016 S 9.
[3] Goqii Technologies Private Limited v Sokrati Technologies Private Limited, (2024) ibclaw.in 289 SC.
[4] Insolvency and Bankruptcy code, 2016 S 9(5) (ii) (d).
[5] Arbitration and Conciliation Act, 1996 s 11.
[6] Mobilox Innovations Private Limited v Kirusa Software Private Limited, (2017) ibclaw.in 01 SC.
[7] Vidya Drolia v Durga Trading Corpn (2019) ibclaw.in 148 SC.
[8] Innoventive Industries Ltd. v ICICI Bank (2017) ibclaw.in 02 SC.
